Good news at last! In recent months, I have endeavored to counter some of the gloom that has pervaded the oil business for the last eight quarters by highlighting fundamentals such as the consistency of long-term demand growth and the reality of larger-than- normal production declines arising from the slump in oil field spending.
This month, I am delighted to report that evidence of these long-term realities is beginning to emerge, with recent data and events combining to create a rosier outlook.
On the supply side, shale oil production declines are accelerating such that it is reasonable to expect year-on-year production to decline by approximately 1 MMb/d by year’s end. With spending on conventional production at minimal levels, it is also reasonable to expect production declines there of more than 3 MMb/d. We have also had a reminder of how unforeseen events can affect supply, with wild fires in Canada restricting supplies by 1 MMb/d and Nigerian supply outages of approximately 500,000 b/d. On the other hand, it was a surprise that Iran managed to increase its production by 300,000 b/d.
Demand looks solid, with China roaring past the US to become the world’s largest car market. New car sales increased 10% in Q1 2016, over the previous year, and sales of sports utility vehicles rose by a stunning 45%. In India, gasoline demand is setting records. The size of India’s vehicle fleet doubled between 2007 and 2015, making it the world’s sixth largest vehicle market. In a move reminiscent of the explosion in Chinese oil consumption growth in the early 2000s, Q1 demand grew by 400,000 b/d over the previous year.
The level of short bets on crude has reduced dramatically, lifting the oil price to the mid US$40/bbl levels. With analysts, the EIA and the IEA now anticipating a tightening of the supply/ demand balance, it’s likely that crude prices will continue to march upwards. Many experts anticipate $60 crude by year end.
With this in mind, it was interesting to attend this year’s Offshore Technology Conference where there was much discussion about what happens next, assuming crude prices do firm significantly. How will shale oil operators respond? Can we expect a rapid reversal in the rig count slump and a consequent ramp up in production that will depress the recovery and prevent prices from rising further? The good news is that there seems to be a consensus among experts that higher crude prices will need to endure for a considerable period of time so that balance sheets can be repaired before rigs will be put back to work in meaningful numbers. I don’t doubt that is true for the majority of shale producers. However, I suspect that we will see the very best shale operators – who have been working hard during the down- turn to develop drilling and completion efficiencies, while driving down costs, and whose balance sheets remain strong – putting rigs back to work before too long.
As we have never been in this position before, it’s impossible to predict what will happen. But, I hope and expect that the industry will get a chance to recover and stabilize before more damage is done.
|Source: US Energy Information Administration|
Colin Welsh is head of international energy investment banking at Simmons & Company International, part of Piper Jaffray. He studied accountancy, economics and law at the University of Aberdeen and qualified as a Scottish Chartered Accountant with Ernst & Whinney (now EY).